Client Understanding Paper
Adjusting lower cost of market inventory on valuation, capitalizing interest on building construction, recording gain or loss on asset disposal and adjusting goodwill for impairment are all areas in which numbers on a financial statement can be distorted. There are rules and regulations regarding each one that a company should follow and auditing of these areas is necessary for financial statement compliance. Any organization must recognize that the GAAP is an ever evolving set of regulations and standards that should be followed.
Using the lower cost of market is defined as comparing the market value of each ...view middle of the document...
Capitalization of interest on building construction is a common accounting practice for an organization. FASB St. No. 34, Capitalization of interest cost establishes standards for capitalizing interest cost as part of the historical cost of acquiring a new asset. (Capitalization of Interest Cost (Issued 10/79)) When interest is being capitalized it is an allocation on a monthly basis of the interest cost that will be incurred during the construction period. The rate to capitalize the interest should be based on the company’s borrowing amount. The main purpose of capitalizing the interest is to come close to measuring the acquisition cost of the purchase of construction being done on a building and to allocate the cost over future periods on financial statements. Any purchase of an asset, especially construction on a building the interest should be capitalized monthly when the construction is going to require six months or longer to be completed. FASB ASC 835-20 states that an institution is required to capitalize the interest cost during the acquisition process or during the construction of an asset. (FASB ASC 835-20) The types of property where the interest can be capitalized under section 263A of the IRS code are:
1. Any real property.
2. Property with a life expectancy of 20 years or more.
3. Personal property with estimated production exceeding two years.
4. Personal property which production cost exceeds $1 million and estimated period exceeds one year.
(Capitalization of Interest Cost (Issued 10/79))
Capitalizing the interest on building construction is basically part of the accrual basis of accounting. (What is capitalized interest?, 2010) This way the entire interest expense is not going to hit the income statement in one given period. It will start off as a fixed asset on the balance sheet and will be expensed over the life of the asset.
There are times in an organization where they will rid the company of unneeded fixed assets by selling them, trading them in to use as a partial payment or simply disposing of the asset that is no longer usable. When this happens the company needs to remove the cost of the asset and any accumulated depreciation from its balance sheet. (Fixed Asset Disposal Accounting, 2012) Any income or loss from a fixed asset that is being removed from the books has to be recorded on the income statement as a gain or loss of an asset. (FASB 350-20-4-1 thru 7)
A fixed asset may be sold anytime during its useful life. This is where the recording comes in from the balance sheet to the income statement. If an asset is sold for any amount different from what was originally recorded on the company’s books, an adjustment must be made to the net income on the cash flow statement. The effect on the statement of cash flows is that the entire proceed received from the sale of the asset must be recorded in the investing activity section. This could potentially present a problem when the gain...